Is Teradyne Stock A Buy?

Teradyne’s future prospects look bright as technology and semiconductors as a whole become more critical to applications. The advanced test solutions company, with attractive valuation, strong fundamentals and a high ROE, is set to benefit from an increasingly complex world.

Teradyne, Inc. [NASDAQ: TER] is an American automatic test equipment (ATE) designer and manufacturer that designs, manufactures, sells, and supports semiconductor test products and services to test electronic and computer components when they are being manufactured. The company operates through four segments:

• Semiconductor Test,
• Industrial Automation,
• System Test, and
• Wireless Test.

Teradyne’s automatic test systems are used in wireless products, circuit-boards, data storage, automotive diagnostic, inspection systems, industrial, communications, semiconductors and electronic systems in the wireless, aerospace, and defense industries.

The company was founded by Alexander V. d’Arbeloff and Nicholas DeWolf in 1960 and is headquartered in North Reading, Massachusetts.

Teradyne Revenue Growth Rate Impressive 

Teradyne’s fourth-quarter earnings, as well fiscal year 2020 results, came out better than expected with both, top and bottom-line, exceeding analysts’ consensus estimates.

The company reported revenue of $759 million for the fourth quarter of 2020, of which $524 million was in Semiconductor Test, $104 million in System Test, $40 million in Wireless Test and $92 million in Industrial Automation (IA).

Revenue grew 16% in comparison to the 4th quarter of 2019. The company reported $1.10 earnings per share for the quarter, beating the consensus estimate of $1.01 by $0.09. For the full year 2020, revenue grew 36% to just over $3.12 billion, while EPS jumped a whopping 62% to $4.62. Teradyne generated $684 million in free cash in 2020.

The stellar results were driven by strength in all of the company’s test businesses, which more than made up for a soft industrial automation market that was impacted by the pandemic, declining 6% for the year.

The global slowdown in manufacturing activity led to a 12% decline in sales at its Universal Robots unit.

Teradyne’s semi-test business was especially strongly driven by investments in smartphone-related test capacity and its expansion into the compute sector of SOC with the company’s new UltraFLEX plus product.

In smartphones, global unit shipments contracted in 2020, but the growth in chipset complexity and strong orders from makers of memory chips, wireless networking modules, and 5G wireless systems, continued driving the demand higher.

With the Test segment showing continued strength and Industrial Automation returning to growth, the outlook for 2021 appears bright across all its markets.

As for outlook of Q1, sales are expected to be between $720 million and $780 million, while EPS is expected to be in the range of $0.95 to $1.11.

The company is resuming its share repurchase program, worth $2 billion, which it suspended in April due to Covid-related uncertainty. The resumption of the buyback program is indicative of the fact that the company’s management has confidence in the worth of its own stock.

Also, it has an active M&A pipeline, with the company setting aside $500 million for different M&A activities.

Chip Shortages A Boon For Teradyne

The testing equipment specialist’s earnings and revenue have been growing at an impressive rate in recent years, and the current chip shortage could advance its cause further. 

In the past three years, earnings have grown at a rate of 29% while revenue has grown by 14% per year.

The world is grappling with acute chip shortage, owing to the pandemic, which severely disrupted supply chains and limited the production of all kinds of chips. This shortage is impacting many different industries such as automotive, industrial, communications, smartphones, and computer and electronic games, to name a few.

With the shortage of chips in mind and manufacturers looking to boost production, there is ever-increasing pressure to shorten time-to-market.

Successful application development and test strategies can refine and drive down the production process, while reducing the cost of test.

As such, companies that ensure your devices work right the first time, so you can significantly reduce the time it takes for the products to reach the market and into the hands of customers, could find themselves in a very advantageous position.

Overall, Teradyne is doing very well from a fundamental standpoint, and the current semiconductor shortage can add further impetus to its revenue and profitability.  Having said that, what happens to its revenue when chip production ramps up?

Teradyne would benefit from it as well as it will lead to an increase in the demand for testing equipment. Add to that a decent dividend, share repurchase program, and fantastic growth across several other market makes, and it is easy to understand why the stock price of this testing equipment specialist has been soaring.

Cyclical Customer Base = Cyclical Financials

One of the potential drawbacks of investing in Teradyne is that its customer base is largely cyclical. What it means is that Teradyne is likely to expect large orders during periods of economic expansion, but the opposite is likely to happen in periods of economic downturn and contraction.

Long-term technological progress is likely to be hampered by recessions and falling output, and this is likely to adversely impact companies like Teradyne.

Also, few of its largest customers are responsible for a bigger portion of the company’s overall sales. There’s a risk involved in it as it could gravely affect Teradyne in case its rivals manage to snatch a couple of its major customers.

The company has paid dividends over a period of seven years, but it still needs to work upon establishing a good record of consistently raising its dividend yield for shareholders.

Moreover, existing analyst estimates suggest that the company’s future payout ratio (proportion of earnings a firm pays to its stockholders in form of dividends) is expected to drop to 8.5% over the next three years. Also, Teradyne’s earnings growth may probably slow down, but it is expected that the company’s ROE will remain alluring. 

Teradyne Competitors Are Abundant

Dominant players in the Semiconductor Test Systems industry, apart from Teradyne, include Advantest and Cohu.

Advantest Corporation (ADTTF) is a leading manufacturer of automatic test equipment for the semiconductor industry, and a manufacturer of electronic measuring instruments.  

Advantest has been flourishing of late, and, thus, the management can be justified in painting a rosy outlook for the company, despite some short-term headwinds.

ADTTF share price seems fairly priced at these levels, with serious upside potential given the high growth expectations of the Semiconductor Back-end Test Systems Industry. The company’s margins have been improving as it continues to benefit from increasing semiconductor complexity, which, in turn, calls for more sophisticated testing equipment.

The three dominant Semi Test Systems companies serve dozens of customers, but they derive a large chunk of their revenues from the following customers:

Advantest = Samsung

Teradyne = TSMC

Cohu (COHU) = Intel (INTC)

While there’s a distinct possibility of a company snatching its rival’s customers, it is less likely in the Semiconductor Test Systems industry, as the systems depend less on advanced technologies and more on applicability across a wide range of semiconductors.

Coming back to Advantest, the company excels in HPC (high performance computing), which is likely to drive SoC (System on a Chip) demand and bolster its revenue.

All in all, Advantest is fairly priced, and enjoys a market share of over 40%. The company’s operating profits and free cash flows are on the high side, and given the expected 4-8% growth the Semiconductor Test Systems market is expected to enjoy over the long term, Advantest should definitely be on your radar.

Cohu, Inc., through its subsidiaries, engages in the semiconductor automated test equipment, inspection equipment, test contactors, thermal sub-systems, and printed circuit board (PCB) test equipment.

Cohu reported very impressive fourth quarter earnings numbers, with the test equipment company generating EPS of $0.73 on revenues of $202.36. Both the top and bottom-lines beat consensus estimates.

What was most impressive during the fourth quarter earnings report was the fact that the company currently enjoys demand across all semiconductor segments. The management expects momentum to continue into the first quarter as well as the second quarter.

Having said that, one sore point for Cohu is profitability, as the company’s operating margin of 3.38% and gross profit margin of 43.32% still falls well short of the sector averages.

Another area of concern from investors’ point of view is that the dividends have been currently suspended and Cohu, unlike Teradyne, has no stock-repurchase plan in operation at present.

To sum it up, Cohu is a distant third in comparison to Teradyne and Advantest. However, the semiconductor market is growing at a fast pace, and Cohu has momentum on its side, which makes it a decent pick in a strong industry segment.

Also, Teradyne’s PE ratio is more or less same as that of its closest competitors, but its profitability metrics are significantly ahead. 

More prominently, it is the only company in its group that pays a dividend, albeit a small yet growing one, and has a solid history of share buybacks when adequate cash is available.

Is Teradyne Stock A Buy? The Bottom Line

Teradyne is a huge name in the automated testing industry. The company tests almost 50% of the over 1 trillion semiconductors sold yearly worldwide.

The company’s Semiconductor Test segment, which also happens to be its largest, caters to a wide range of industries, ranging from automotive and industrial markets to high-end smartphones and their 5G connectivity.

All these industries are currently in a hyper-growth mode, which means Teradyne stands to hugely benefit from increasing semiconductor advancement and complexity.

Driven by steady test intensity growth of terabyte HDD drives and similar growth in the system level test of complex semiconductor devices, prospects look bright for the company’s second biggest System Test division as well. And in Wireless Test, sales grew 10% from 2019 with solid demand for both its connectivity and cellular end markets.

Finally, and in what may just be Teradyne’s most intriguing business segment, Industrial Automation, which includes collaborative and mobile robots that help manufacturers of all sizes improve productivity and lower costs, was weaker than expected with global slowdown in manufacturing activities.

But the business finally started to see light at the end of the tunnel, with results improving dramatically in the second quarter of 2020 and with record sales at its biggest unit, Universal Robots (UR), in the fourth quarter.

In conclusion, as the world becomes more technologically advanced, Teradyne, with its strong cash generation capability and its prudent M&A strategy, is all set to reap rich dividends across all of its business segments.

The company is reinvesting heavily into its business and generating a high rate of return. The company is scheduled to report first quarter earnings next month, and analysts expect earnings’ increase of 5% in comparison to the same period last year.

For 2021 as a whole, earnings are expected to increase by 4.1% while revenue is expected to rise by 6.1%.  Teradyne is expected to receive further boost in revenue from the current semiconductor shortage.  It also stands to benefit when chip production ramps up as, in that case, there would be higher demand for its testing equipment.

Overall, strong fundamentals, a steady dividend yield and a growing demand for its products, makes this industrial automation company worthy of investors’ attention and money.

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